The Breakdown - Genesis and Gemini Earn Halt Withdrawals as FTX Contagion Spreads

Starting point is 00:00:00 Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by nexus.io, Circle, and Cracken, and produced and distributed by CoinDesk. What's going on, guys? It is Wednesday, November 16th, and today we are catching up on FTX Contagion, as well as some interesting things from the macro world. Before we get into that, however, if you are enjoying the breakdown, please go subscribe to it. listen, give it a review, or if you want to dive deeper into the conversation, come join us on the Breakers Discord. You can find a link in the show notes or go to bit.ly slash breakdown pod. All right, guys, how is everyone doing out there? Now, I mentioned it yesterday, but I wanted to tell you

Starting point is 00:00:49 again about the upcoming Grateful for Bitcoin series next week. I've started recording those interviews as of today, including one about Bitcoin gas flare mining today that I think you're really going to like. I also want to say welcome once again to Cracken as a partner for the breakdowns back to basics theme throughout the rest of this year. Now, today, I want to catch up on a few of the macro stories we've missed, as we've been very understandably focused on the crypto industry, but unfortunately first we do have to look at the latest contagion from FTX's collapse. Genesis trading is one of the larger players in the institutional crypto space. They're one of the crown jewels in the digital currency group empire, which should be noted also includes

Starting point is 00:01:28 coin desk. Their lending arm is called Genesis Global Capital, and at the end of the third quarter, it had $2.8 billion in total active loans. Now, Genesis has had a rough year. They suffered nine-figure losses, a few hundred million dollars through their exposure to Three Arrow's Capital and Babel Finance earlier this year. In June, Michael Morrow said, as we already stated on June 17th, we mitigated our losses with a large counterparty who failed to meet a margin call to us. We sold collateral, hedged our downside, and moved on. Our business continues to operate normally, and we are meeting all of our clients' needs. still, losing a few hundred million dollars is going to have some consequences, and in the wake of all

Starting point is 00:02:07 of this, CEO Michael Morrow stepped down. Perhaps unsurprisingly then when FTX collapsed, one of the big questions was what exposure Genesis had. Initially, they said they only had something like $7 million of exposure, but then that was revised up to about $175 million in locked funds in its FTX trading account. Because of this last week, DCG decided to strengthen their balance sheet with an equity infusion of $140 million. In spite of this, last night, rumors of solvency issues, were perhaps liquidity issues, started to make their way to Twitter. Satoshi Stacker wrote Breaking, there are rumors about Genesis trading being insolvent despite receiving an infusion of $140 million a few days ago. The parent company of Genesis is DCG, which is also the parent

Starting point is 00:02:49 company of Grayscale. Grayscale is one of the largest holders of Bitcoin worth $11 billion. This morning, it was revealed that the issue was not with Genesis trading, but with Genesis Capital. Frank Chaparro from the block tweeted Genesis just held a seven-minute call with clients to let them know withdrawal requests for Genesis Capital have exceeded their liquidity profile. CEO says he's working on a plan with advisors to fix their liquidity profile and serve clients. Amanda Cowie, Vice President of Communications and Marketing at DCG, released a statement that said, Today, Genesis Global Capital, Genesis's lending business, made the difficult decision to temporarily suspend redemptions and new loan originations. This decision was made in response to the extreme market

Starting point is 00:03:28 dislocation and loss of industry confidence caused by the FTX implosion. This decision impacts the lending business at Genesis and does not affect Genesis' trading or custody businesses. Importantly, this decision has no impact on the business operations of DCG and our other wholly owned subsidiaries. Still, one of the fallouts from the Genesis Capital withdrawal shutdown is the Gemini Earn Program. The team at Gemini released a statement this morning that says, We are aware that Genesis Global Capital, the lending partner of the Earned Program, has paused withdrawals and will not be able to meet customer redemptions within the service-level agreement of five business days. We're working with the Genesis team to help customers redeem their funds from the Earned Program as quickly as possible.

Starting point is 00:04:08 We will provide more information in the coming days. This past week has been an incredibly challenging and stressful time for our industry. We are disappointed that the Earn Program SLA will not be met, but we are encouraged by Genesis and its parent company Digital Currency Group's commitment to doing everything in their power to fulfill their obligations to customers under the Earn Program. We will continue to work with them on behalf of all earned customers. This is our highest priority. We greatly appreciate your patience. Mike Dutas from Sixth Man Ventures said, to be clear, this isn't a hit to Gemini's deposit base, but it's a hit to the market value prop and trust surrounding the concept that customers can

Starting point is 00:04:41 earn safe, reliable yield on their crypto via a regulated exchange. Not trying to fud here, and I expect Gemini deposits are fine. End quote. Still, after everything that went down with FTCX, what people want is details. Jason Choi wrote, no exact figures in still having issues post-DCG infusion are not confidence-inspiring. Bantig responded to Jason saying, fully operational but temporarily halting origination and withdrawals, this seems like another way of saying insolvent. Jason responded, I don't know, just repeating exactly what was said. Could be a duration mismatch, could be insolvency. If former, good. If latter, pray. Want to keep more profits when trading? Get the best possible prices and trade with 50,

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Starting point is 00:06:47 And award-winning client engagement teams are available for support 24-7. Buy crypto instantly with fast, flexible funding options on Cracken. Download the Cracken app on Google Play or the Apple App Store, or visit crackin.com to join. Now, over the last couple of hours, as I was working on the show, the situation with Gemini seemed to get worse. Numerous commentators noticed that it wasn't just earned but the entire exchange that seemed to be down.

Starting point is 00:07:16 There were outages across the web UI, the mobile app, the Earn Program, the exchange trading engine, numerous APIs, and more. However, according to the latest tweet from Gemini, it was all about AWS. Quote, we experienced an Amazon Web Services EBS outage with one of our primary databases. We've restored the database and are bringing the exchange back up. Alex Kruger gives probably what's the simplest explanation, saying, guessing Gemini withdrawal is not working at the moment because Gemini Earn got shut down due to Genesis lending, leading everyone to withdraw at the same time equals website issues.

Starting point is 00:07:48 Either way, please DIYR if you have your funds in Gemini. Now, obviously, we will continue to keep an eye on this, but in the meantime, it is probably a good time to withdraw your assets to self-custody if you haven't done so already. Now, with that, let's shift to some of those macro stories that I mean. mentioned we haven't had a chance to cover. And to be clear, there's not necessarily a theme here, just the latest things that are important to note. Let's start with the CPI. One of the biggest pieces of news that got blown out of the water last week by Sam and FTX was the inflation print coming in at 7.7%, pretty significantly under what was expected. This was a major driver of the

Starting point is 00:08:22 equities rally that led to the most significant divergence between Bitcoin and risk equities in the last few years. Unfortunately, the inflation data may not be as good as it seems. A quirk in the CPI data has been causing a lot of discussion among financial Twitter. Last month's inflation data showed a 4% reduction in health insurance costs, but as a result of the annual adjustment from the Bureau of Labor Statistics. While the reduction in headline inflation to 7.7% was a welcome change of pace, some are questioning whether the data could really be viewed as a turning point for inflation if a significant portion of the reduction is attributed to this one-time adjustment.

Starting point is 00:08:54 The change cut around eight basis points from core inflation, which held steady from the previous month and would have risen without this adjustment. health insurance costs did not just suddenly collapse in October, leaving more questions about how real this peak in inflation will prove to be. Matt Fielder, a senior fellow at Brookings Institution said, No, today's health insurance CPI reading does not mean that premiums fell 4% in October. In fact, it's not really about premiums at all. It mostly reflects events that are over one year old. Jason Furman points out that lags are actually going in both directions right now. The professor at Harvard said lags in shelter now lead the measure to overstates spot core inflation by about 20 basis points.

Starting point is 00:09:30 Health insurance is the opposite as of October because CPI shifted from 2020 to 2021 utilization. This subtracts around eight basis points for core inflation and will for 11 more months. Now, in spite of this, obviously, equities markets have been doing really well. And what we've seen over and over again is that whenever the markets get out ahead of where the Fed really thinks inflation is, they tend to send out speakers to tamp them back. On Monday, Federal Reserve Governor Christopher Wallace did in fact push back on markets, saying that they had responded far too strongly to one favorable CPI report. Quote, the market seemed to get way, way out in front.

Starting point is 00:10:05 I just cannot stress this as one data point. We've still got a ways to go. He noted that so far, rate hikes have not broken anything, and that to see significant slowdown, the Fed would need to see consecutive positive data points confirming that inflation was cooling off. That said, he did acknowledge that the Fed would be considering a smaller 50-bases-point hike at their December meeting.

Starting point is 00:10:24 Now, to the extent that the Fed was trying to have Waller be hawkish, later that day, Fed Vice Chair Lail Braynard played the dove. She said, quote, I think it will probably be appropriate soon to move to a slower pace of rate increases. Now, she hedged a little by saying, I think what's really important to emphasize is we've done a lot, but we have additional work to do on both raising rates and sustaining restraint to bring inflation down to 2% over time. With the dollar coming off its highs in the last week and equity market staging a significant rally, questions remain about whether the Fed can maintain tight financial conditions as they begin to slow rate hikes. Braynard said, quote, we have raised rates very rapidly.

Starting point is 00:10:56 and we've been reducing the balance sheet. And you can see that in financial conditions. You can see that in inflation expectations, which are well anchored. Former Fed trader Joseph Wang said, what surprised me most about Braynard's interview was that she seemed to be open to cuts next year. When asked point blank for potential cuts, she could have suggested higher for longer or no anticipation of cuts, but did not do so. Brent Johnson wrote, is there any doubt regarding the ongoing battle for control of the narrative between Powell and Braynard? Still not everyone is convinced that we should be hopeful right now. Sergei Perfiliyev, a former Goldman Sachs quant, said, Much hopium in the markets right now.

Starting point is 00:11:32 If Fed pivots and starts easing before inflation is firmly lower, the risks of Fed's credibility are substantial, especially following their hesitation in 2021. It may not be the risk they're willing to take. They need to prove themselves. Uri and Timmer, the director of Global Macro at Fidelity, said something similar. There was an instant reaction to the hopeful inflation report, he writes.

Starting point is 00:11:51 But if financial conditions ease much further, it may well force the Fed to throw cold water on the rally. I expect any cautious optimism from the Fed to be tempered with ongoing hawkish talk. Now let's look at some specific sectors of the economy. A new study from the Dallas Federal Reserve found that the recent spike in mortgage rates could cause the U.S. property market to dump by 20%. The pessimistic scenario from the study had a drop of 15 to 20% in house prices, which could reduce inflation adjusted consumer spending by up to 0.7%.

Starting point is 00:12:19 The research article, entitled Skimming U.S. housing froth a delicate, daunting task, showed that a reduction in consumer spending this large could harm the Fed's ability to avoid a recession. The paper states such a negative wealth effect on aggregate demand would further restrain housing demand, deepening the price correction and setting in motion a negative feedback loop. The Fed has, of course, raised interest rates 3.75 percentage points this year, which has driven the average U.S. 30-year mortgage fixed interest rate above 7%. That's more than double the 3% seen at the end of last year. Mortgage debt service payments as a share of disposable income was forecast to reach 6% by the end of the end of the last year. The mortgage debt's

Starting point is 00:12:53 end of the third quarter this year, up from 3.9% the previous quarter. The Fed article said, quote, achieving a soft economic landing, taming inflation and avoiding a recession as the Fed accomplished in 1994, cannot be taken for granted given that further monetary policy tightening can increase the household mortgage debt servicing burden and boost the odds of a severe house price correction. According to Charlie Belayo, the CEO of Compound Capital Advisors, this increase in mortgage rates and stubbornly high housing price means that the average down payment has increased by $25,000 in two years, while the average monthly payment on a newly issued loan has more than doubled. Nick Timrose from the Wall Street Journal pointed out just how much this is crushing the market.

Starting point is 00:13:32 The average 30-year fixed mortgage rate, he writes, has been above 7% for the last three weeks, something that hasn't been seen since 2001. Applications for home purchase mortgages, meaning excluding refinances, are down 40% on the year, per the Mortgage Bankers Association. D.R. Horton, the largest U.S. home builder, reported net sales orders in July to September quarter fell 15% from a year earlier and by 10% in value. Canceled sales orders as a share of gross sales rose to 32% from 19% in the year earlier period. Redfin will lay off another 13% of its staff, bringing total staff reduction since April to 27% and close its on-demand buying service Redfin now. One more big-picture power shift story on the macro side as we close this out,

Starting point is 00:14:13 one of the big questions ever since the beginning of COVID, but especially over the last year, has been the reshoring of manufacturing of important silicon chips. Right now, a huge portion of the world supply of chips is built in the Taiwan Strait, and many in the American establishment don't think that that is viable in any sort of medium or long-term scenario. Well, this week we got news that Apple is planning to begin sourcing chips from a plant that is still under construction in Arizona from 2024 forward. The move will be a significant pivot away from reliance on a supply chain based in Asia. CEO Tim Cook disclosed the move in an internal meeting in Germany with local engineers and retail employees. Cook said, quote,

Starting point is 00:14:51 We've already made a decision to be buying out of a plant in Arizona, and this plant in Arizona starts up in 24, so we've got about two and a half years ahead of us on that one, maybe a little less. The Arizona plant that is being referred to is likely the facility being set up by TSM, the Taiwan-based semiconductor manufacturing giant. This would be part of their diversification strategy, which seeks to set up more manufacturing capacity outside of Taiwan. More broadly speaking, the U.S. government plan to onshore chip production has resulted in several manufacturers breaking ground on U.S. facilities this year. At the moment, Taiwan currently produces 60% of the world's supply of chips, and Tim Cook again said, regardless of what you may feel and think, 60% coming out of

Starting point is 00:15:28 anywhere is probably not a strategic position. The diversification of the semiconductor supply chain has been a key strategic goal of policymakers in the U.S. and Europe over the last few years. Now, notably, this announcement from Apple does not represent the ability to source components entirely from the U.S. Plan facilities simply will not have the necessary production capacity or the technological capabilities to produce cutting-edge chips. But it does, however, represent the first big move from the tech giant to move its supply chain away from Asia. One more time from Tim Cook,

Starting point is 00:15:57 I think you will wind up seeing a significant investment in capability and capacity in both the United States and Europe to try to reorient the market share of where silicon is produced. So that is the view from here, guys, more crypto-contagion working its way through the markets, big changes in how the world economy organizes itself, and all of us just sitting here desperately waiting for next week's Thanksgiving holiday. For now, I want to say thanks again to my sponsors,

Starting point is 00:16:20 nexus.io, circle and crackin, and thanks to you guys for listening. Until tomorrow, be safe and take care of each other. Peace.

The Breakdown - Genesis and Gemini Earn Halt Withdrawals as FTX Contagion Spreads

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